my thoughts on The Debt Virus Hypothesis

[Pianist4Freedom]

A popular hypothesis which has been espoused numerous times on this forum is the statement: "Once new money has been loaned out of thin air, where does the money come from to pay the interest?"

It seems to me that this is making the assumption that there was no money at all in circulation before the fractional reserve lending began. But we all know that before fiat money existed, we had commodity backed money. That's very simple: whoever digs it out of the ground first can spend it, and presto, it's in the economy.

Then, the government comes along and says: "give me all your precious metal, and I'll give you paper that you must accept in exchange for the same stuff you would have exchanged your precious metal for." So at least initially, everyone still has the same purchasing power. But as many of you will point out of course, now inflation can begin.

Now, a bank can make a loan to someone out of thin air..charge interest...and if that person earns enough money to pay off the loan at interest (by selling to people who hold all that old money that was in circulation previously), then it is clear the debt virus doesn't really happen.


However this has led me to other questions: One of the nice things about commodity backed money and 100% reserves is that nobody has any obligations to anyone. It is truly the ultimate libertarian monetary system. Is it possible for all debts to be paid off in a fractional reserve lending fiat monetary system such as we have?

I've done thought experiments on this issue and it looks as though if all debts were paid off, you'd return to the same amount of money that was in circulation before the fiat money system was created. This is assuming, however, that NOBODY defaults on a loan which is unrealistic.

Which leads me to another question and I'm bolding it because it is THE question I haven't yet found an answer for: Is Loan Default the ONLY way that money can permanently enter the system? (so that it is not a liability to anyone, it's just money in someone's bank account that they earned?)

 

[tmosley]

That's how I understand it.

 

[Pianist4Freedom]

I'm honing in on the truth. Is it really permanent even then? What about when the government taxes that money back out of someone's hands and pays off a bond, which was the original backing for the currency to begin with? Man...our system is psycho.

 

[WRellim]

I'm honing in on the truth. Is it really permanent even then? What about when the government taxes that money back out of someone's hands and pays off a bond, which was the original backing for the currency to begin with? Man...our system is psycho.

As we've discussed in private messages... it is not necessarily "permanent" -- but such money may persist within the system for such a "long-term" (two iterations of a 30 year T-Bill is 60 years... essentially a full lifetime; 3 or 4 such iterations and it is effectively "permanent" as far as any one man's lifetime is concerned. Only their children or grandchildren will be stuck with the final bill! It's like you see those "Buy now, pay later!" offers from furniture and carpet stores the ones with "No Payments or Interest for a year!" -- well, just extend that out "Buy now, let your grandchildren pay it off! Interest, but NO payments for a century! Screw your kids!!!" )

IMHO, in the ethical sense, that type of "long-term persistent fiat money" is actually WORSE than being "permanent" kind that comes from counterfeiting. (Because EVENTUALLY it will have to be either REPAID, or have ASSETS confiscated {they take the now "heirloom" carpets and furniture back} or it will have to be DEFAULTED on.)

Man...our system is psycho.

"Psycho" would be a fairly apropos term if by it you mean not simply "crazy" but literally the textbook definition of "psychopathic" (though the preferred term is actually "sociopathic"; meaning literally a "society destroyer") and that would be quite accurate, as that IS what it will eventually do... KILL / DESTROY our "society" (aka "It's the end of the world as we know it").



BTW, as an aside, most of the worst power-seeking politicians actually DO qualify as sociopathic on Hare's PCL-R (which is an objective measure based mainly on public records and case history data and which does NOT require a face-to-face knowledge of or interaction with the subject... and yes, I've been properly trained in doing the analysis -- literally, the PCL-R is NOT available to the public). Anyway, as a "hobby-exercise" I've done the PCL-R numbers on George W. Bush, John McCain, AND on Hilary R. Clinton and, alas, -- given certain assumptions concerning the accuracy of incidents in their pasts (for instance, assuming "lost" police records actually existed as described by authorities/witnesses) but even then, with some discounting of about half of those events -- well, all 3 of them are STILL so far into the "sociopath" range that there is little doubt. (Scary conclusion, I know).

Of the remaining candidates, only Barack Obama and Ron Paul come out of the PCL-R solidly in the lower number ranges as human beings with "normal" consciences in tact. (Note: I do NOT endorse Obama, because I believe he has bad policies and political stances... but I do NOT fear him as I do McCain and Clinton -- they scare me as much as Bush did. {And my predictions -- via PCL-R -- about Bush back in 2000 have virtually all come true! I wish they hadn't!}) Yet another solid reason to vote for Obama or Paul.

P.S. I always wished R. Hare would literally get off the fence on this... I know (conversation at a bar after a conference) that he in fact DOES do private (NEVER published) analyses of politicians on a regular basis... maybe someday he'll be so close to death that he won't be afraid of revealing that (and the underlying analyses) in a VERY public way. Maybe there will even be a "posthumously published" book? Egads I hope so.

 

[WRellim]

Now, a bank can make a loan to someone out of thin air..charge interest...and if that person earns enough money to pay off the loan at interest (by selling to people who hold all that old money that was in circulation previously), then it is clear the debt virus doesn't really happen.

Actually, the loan is not REALLY made "out of thin air" -- but only "virtually" so (there must be some substantial level of ACTUAL money in the bank -- substantial enough to actually MAKE the loans with currency, and also to still convince people to "believe" the illusion and promote their confidence enough to leave sufficient "recycled" deposits on hand to allow the bank to engage in a SOLIDLY convincing version of the "juggling act").

It is much like you and the gang of neighborhood boys all subversively "borrowing" money from your brothers piggy banks (with the brothers all "assuming" the money is still there... and as long as you replace the right amount of money (or enough "slugs" to pass a "shake-and-weight-test") ...well, no "panic" happens and all is well ...at least until Christmas when everyone's brother smashes their piggy banks to find nothing but slugs ...and neighborhood-wide beatings of little brothers ensue!) :o

BTW, again as we have discussed separately (and I have written in other threads) this type of "credit money" is a part of the "Fractional Reserve Banking system" rather than being an aspect of "fiat money" -- It does NOT require a fiat money system to exist -- indeed it both CAN and DID exist when the US was on a 100% gold standard. (The difference being that the GOVERNMENT itself did not engage in creation of such "credit money" other than in the form of "War Bonds" and "Savings Bonds" which had specific redemption dates, etc. and which thus were significantly more "transparent" as being loans of existing cash, rather than some form of "created money").

However this has led me to other questions: One of the nice things about commodity backed money and 100% reserves is that nobody has any obligations to anyone. It is truly the ultimate libertarian monetary system. Is it possible for all debts to be paid off in a fractional reserve lending fiat monetary system such as we have?

Again, don't conflate the two. Fiat money is when the issuer of the currency itself is playing games with the money supply. Fractional Reserve Banking is a separate issue. (But granted the combination of the two DOES occur in our current system... which makes matters more confusing.)

To help you with your confusion, I'd suggest that you read about the failure of various banks in the late 1800's and early 1900's (prior to 1913 and the creation of the Federal Reserve System) -- in many cases banks DID in fact "push things too far" and the resulting "panic" normally resulted in the literal "rupture" of the "banks" (hence the term "bank-rupt") -- many bankers would commit suicide as they faced the literal loss of ALL their assets (and probably criminal punishment as well). Basically the balance of the universe was restored (though many "investors" and "depositors" had to endure significant LOSSES to restore that balance.)

The problem is that people want to earn "interest" in a pain-free and entirely risk-free way -- but in order to do so, they either have to delude themselves that their money is NOT being borrowed out at X multiples, OR the system has to (eventually) steal from others in order to "guarantee" their deposits. (Again, faulty assumptions... you cannot gain profit without assuming risk and possible loss).

I've done thought experiments on this issue and it looks as though if all debts were paid off, you'd return to the same amount of money that was in circulation before the fiat money system was created. This is assuming, however, that NOBODY defaults on a loan which is unrealistic.

Again... don't conflate the two. In a Fractional Reserve Banking system, if all debts were paid off (and then in a timely fashion) all deposits returned to their owners, then... YES, you would return to the same amount of money that was in circulation before the "credit money" was created.

In a FIAT money system -- this is also true, but with FOUR important provisions/caveats.

1) That "fiat" systems normally endure for much LONGER periods of time, indeed frequently over more than one generation (and in our case, several generations depending on whether you feel our system became "fiat" back in 1913, in 1933 under FDR, or in the 1960's under LBJ, or only when it became "blatant" with the "suspension" by Nixon in 1971). This longer period of time is important because it increases the chances of the likelihood of violations of the following three provisions/caveats:

2) The second provision is that ALL records were properly kept during the ENTIRE timespan since the inception of the "fiat" system. In other words, at no time did ANY of those administrations engage in literal "off-the-books" printing of dollars WITHOUT the required sale of Treasury Bills. (BTW, there is substantial circumstantial evidence that this is EXACTLY what the LBJ administration DID in fact do during the Vietnam years -- with large volumes of "counterfeit" paper money being used in foreign transactions with NO on-the-books liabilities. This resulted in the "Balance of Payments" crisis, the loss (and potential GREATER loss) of Gold during the early Nixon years, and the subsequent unilateral ending of Bretton Woods Accord. Whether Nixon and other administrations since have continued the practice is a good question; but is there any doubt that an administration that would {for example} do the Iran/Contra deal in a covert way and then LIE to Congress about it... would be willing to also do a little "counterfeiting" on the side... is THAT within the realm of possibility? IMHO, that question is rhetorical in nature.)

3) The third provision is that the amount of DEBT created by the fiat system has NOT been allowed to get SO LARGE that it cannot be reasonably paid off by a "bearable" amount of taxation (one that can be instated without destroying the economy or causing too deep of a recession).

4) The fourth and final provision is that the "governors" of the fiat system actually have the self-discipline to pay the debt off. Obviously in order to pay off debt, especially large amounts of debt, one must have a long-term continual POSITIVE cash flow (i.e. REAL budget surpluses rather than budget deficits... and not simply from "monkeying" with the semantics of on-budget versus off-budget, or robbing Peter to pay Paul... we're talking truly collecting MORE in taxes than one ACTUALLY spends, and NOT falling to the temptation to spend that surplus).

And the likelihood that this final provision will happen under the watch of our current political system... well how did Jiminy Cricket phrase it: "A dream is a wish your heart makes when you are asleep." ?


In the end... whether it is now, 5 years from now, 20, 50 or 100, then books will HAVE to be balanced... and substantial LOSSES will be endured by someone (or many someones). This is true whether it is repaid by taxation, by hyperinflation, or by literal default.